Exchange Views: ASX - Ramping Up For Algo/DMA Trading

In common with other exchanges around the globe, the ASX has seen algorithmic and
automated trading fundamentally change the nature of its order flows. AT talks to David
Stocken, Senior Product Manager, Equity Products at the ASX about how the exchange is
responding to this fluid environment.

David Stocken

How has algo/DMA trading grown as a percentage of the ASX's
activity?

DMA/algo trading now accounts for approximately 25% of turnover
by value on the ASX. This is up from approximately 20% about
twelve months ago. Over the last eighteen months we have been
working on several initiatives to enhance DMA and algorithmic
trading, including:

The introduction of anonymous trading in November 2005, which
has helped institutions reduce their footprint and therefore also
their market impact.

The introduction of a FIX interface to our trading platform.

Moving to a new trading platform (ITS), which combines lower
latency and greater capacity.

A new fee structure (based more on value rather than volume)
for brokers. All of these initiatives have helped facilitate
DMA/algo trading on the exchange. How high will these volumes go?
I am sure we will continue to follow the international trend
upwards. All end users that I speak to plan to increase their
electronic trading activity in coming years.

In an interview in July 2005, former ASX CEO Tony D'Aloisio said
that algorithms were being used on the exchange by the full range
of institutional investors (pension funds, hedge funds and
investment banks etc). Is activity pretty evenly balanced or does
one group predominate?

I would agree that algorithms are being used by a full range of
institutions. Some hedge funds may simply prefer to auto-execute
and therefore prefer DMA. Other hedge funds may trade off
technical signals and then prefer to use an algorithm to execute
their stock. Several of the Australian fund managers I speak to
are also using algorithms. So I would say that algorithmic usage
is pretty evenly balanced across a wide range of users.

In the same interview he said that most ASX DMA business comes
from offshore. Is that still the case? Do you expect the balance
to change and domestic DMA activity to grow?

There is no doubt that a large proportion of our DMA activity
comes from off-shore. Offshore funds have probably been exposed
to algorithms for slightly longer than our domestic fund managers
and therefore feel more comfortable with them. However I would
have to give our domestic funds industry high marks for quickly
learning about the benefits of algorithmic trading. In a short
space of time our domestic funds have really increased their
knowledge and usage of algorithms. But I would expect both
offshore and onshore fund managers to increase their DMA activity
in coming years.

ASX trade count and average trade size

Who do you see as the customer category with the greatest
potential for algorithmic trading growth?

I would say Asian hedge fund sector would be a strong potential
candidate for this title - especially since it is expected to
show very substantial general growth over the next few years.

What effect have the ASX pricing changes had on capturing algo
flow?

The new pricing for brokers came into effect on July 1 2006.
Basically we moved away from our old volume pricing structure
towards a value pricing structure that gives the DMA/algo broker
more pricing certainty.

The immediate effect was a dramatic drop in average trade size in
July, down to about $25000. However since then the average trade
size has levelled off but is still lower than under the old
pricing system. This implies that more algorithmic activity has
occurred since our pricing change. Our trade count has also risen
aggressively. However it must be said that there are many other
factors behind this, including the current strong bull equity
market.

What is the current position with regard to the proposed changes
to ASX crossing rules?

The exchange is reviewing a number of its crossing rules in
response to market feedback. All proposed changes need to be
discussed with the regulator, ASIC (the Australian Securities and
Investments Commission). At this stage, we're not in a position
to outline what those changes might be.

What have been the main changes to the ASX trading platform(s) as
regards connectivity and throughput?

Recent improvements to connectivity and throughput have come
through the implementation of the Integrated Trading System
(ITS). All products that were previously traded through two
trading systems (SEATS and CLICK) are now available on a single
platform and therefore a single connection/ API. We are also now
able to offer contingent trading across multiple product types.

What technology is the ITS infrastructure based upon?

The ITS system consists of a cluster of five OpenVMS systems
spread across two locations. This is then connected via ASX's
fully redundant private network to gateways (Windows servers)
based at participant sites. For overseas participants and for
participants who don't wish to house the gateways on their
premises we also offer a hosting facility where the gateway is
located on ASX premises and the participant connects to the
gateway via a VPN connection.

ITS replaced the SEATS mainframe based system, which was some
twenty years old. In common with other exchanges, we have seen
message volumes increase substantially on the back of DMA and
algorithmic trading.

The ASX then... and now

Do you provide a colocation service so that customers can run
their algorithms on servers based at the exchange?

At present we don't provide this particular service, although as
I mentioned earlier we do offer locally hosted exchange gateways.
However, we are aware that there is customer demand for
colocation and that other exchanges provide it, so we are
currently reviewing this.

What sort of performance levels can ITS achieve?

ITS has been built to handle large volumes and to provide fast
order transaction capabilities. We have successfully tested it to
over 4,000 order book changes per second sustained, for peaks of
over 8,500 order book changes per second, over 200 trades per
second sustained, 500,000 trades per day and 60 million order
book changes per day. Order latency has reduced by 3-4 times
since the move from SEATS to ITS. Typically entering an order and
receiving an acknowledgment takes around 30 milliseconds
(including network latency) but can be as low as 15 milliseconds.

In addition to performance gains, ITS also introduced a new
transaction type particularly suited to algorithmic and DMA
trading. This transaction type allows the entry of multiple
orders in a single transaction.

What is the exchange's strategy as regards FIX?

We have two FIX services, both of which are live. The first is
the Cameron Universal Server. The adaptation required for this
software to connect to ITS was introduced in partnership with
Cameron Systems. The product supports FIX versions 4.0 - 4.2. We
chose this product because of Cameron Systems' reputation for
having the lowest latency FIX engine and we have not regretted
that decision. We currently have a small number of participants
who connect this way but this is already growing. The Cameron
Universal Server is also available as a separate product from
Cameron Systems and we have a few participants who have chosen to
go this route, as Cameron offers a number of additional features
to allow easy integration with a participant's internal systems.

The second FIX service is the FIX market data service also
provided by Cameron Systems. This provides real-time market
information in FIX format. We have a number of participants and
data vendors who receive market data in this form. Certainly for
international participants and data vendors it is easier and
cheaper to maintain systems that talk FIX to multiple exchanges
than to have to connect using each exchange's proprietary API.

Furthermore, the ASX is a member of the FIX Protocol Exchanges
Working Group for Asia Pacific. We use our membership of this
group to keep abreast of FIX developments.

What is the ASX view on the FIX FAST protocol? Will the exchange
be adopting it?

In terms of FAST, we are likely to upgrade to this for market
data. The standard is still very new so we will wait for more up
take before proceeding. FAST's reduction in bandwidth utilisation
is certainly attractive, as it will reduce the cost of
disseminating data whilst simultaneously increasing the speed.

Are you starting to see growth in algo trading of futures as well
as equities?

Yes, algorithmic futures execution is definitely expanding. The
recent merger of ASX and the Sydney Futures Exchange (SFE) is
very interesting in the context of algorithmic execution
expanding beyond equities to other asset classes, such as
futures. Futures algos are more about opportunity discovery
rather than the finessing of order execution often associated
with equities. On the SFE algos are probably used more to
identify trading opportunities based on complex combinations of
circumstances, eg, spread trading opportunities between
futures/futures, futures/cash, currency movements and all other
variations of the same theme, or alternatively high frequency
trades based on changes in technical analysis indicators or
cutting edge quant theory. It is also worth pointing out that the
SFE's trading platform SYCOM is FIX based. As a newly combined
entity, the ASX will look to bring SYCOM into line with current
FIX standards thereby ensuring a consistency between ITS and
SYCOM.

Is high frequency automated trading of futures already
commonplace on ASX/SFE?

Absolutely; and furthermore we are increasingly seeing more and
more end customers demanding direct access beyond that offered by
the brokers based on latency, order management and algo
requirements.

Have you seen much evidence of multi asset algorithmic trading as
yet?

There has been a lot of talk about this at conferences of late,
but as yet we haven't had customers approaching us about it.
However, it seems inevitable that it will eventually take off.

Do you see algorithmic trading of options as the next evolution
for the ASX/SFE?

This is a fascinating development in the algorithmic evolution. I
was formerly an options market maker for many years and am
heavily involved with the development of our Exchange Traded
Options market at ASX. I have been reading with great interest
about the progress that some brokers are making developing
algorithms for ETO execution. While I understand that these
algorithms are more complex to develop than regular equity
algorithms I think their development is very important.

Despite having a healthy ETO market with good liquidity in our
top tier of stocks we still have a lack of "patience" when it
comes to dealing ETOs in size. For example, an institutional
dealer will typically prefer a broker to execute their line of,
say, 1000 options in one print so that the institutional dealer
can move onto his next item of business. Unfortunately there is
market impact when dealing 1000 options in one line. Naturally
the market maker wants to factor in some comfort factor for
dealing size.

However, the institutional dealer should have a lower market
impact if he deals his 1000 options in, say, 100 blocks of 10
steadily over the day. ASX has a very sophisticated ETO market.
We were one of the first markets to introduce tailor-made
combinations and have a high usage of derived bait orders. I
think institutional dealers would be pleasantly surprised about
their ability to successfully deal ETOs via an algorithm with
lower market impact, particularly on the liquid ETO stocks at the
ASX. Just as the buyside agrees that market impact on equities
can be reduced via the use of an algorithm, the same should hold
true for ETOs. To that end we would welcome brokers looking to
introduce algorithmic ETO execution on ASX.